WACO FIN. v. NATIONAL ASS'N OF SEC. DEALERS

• Decision Date: 24 April 1981
• Docket Number: No. K81-73 CA4.,K81-73 CA4.
• Citation: 513 F. Supp. 758
• Parties: WACO FINANCIAL, INC. and J. Jerome Prevatte, Plaintiff, v. NATIONAL ASSOCIATION OF SECURITIES DEALERS, INC. and Securities and Exchange Commission, Defendants.
• Court: U.S. District Court — Western District of Michigan

513 F. Supp. 758

WACO FINANCIAL, INC. and J. Jerome Prevatte, Plaintiff, v. NATIONAL ASSOCIATION OF SECURITIES DEALERS, INC. and Securities and Exchange Commission, Defendants.

No. K81-73 CA4.

United States District Court, W. D. Michigan, S. D.

April 24, 1981.

Theodore H. Amshoff, Jr., Louisville, Ky., Robert D. Mollhagen, Kalamazoo, Mich., for plaintiff.

Andrew McR. Barnes, Washington, D. C., for NASD.

Michael K. Wolensky, Washington, D. C., Mary Weiss, Chicago, Ill., Robert C. Greene, U. S. Atty., Grand Rapids, Mich., for SEC.

OPINION

BENJAMIN F. GIBSON, District Judge.

This suit involves plaintiff WACO's status as a member of the National Association of Securities Dealers, Inc. (hereinafter `NASD') and that of its president, plaintiff J. Jerome Prevatte as a registered financial principal. It is presently before this Court pursuant to plaintiffs' motion for a preliminary injunction.

The relevant facts are simple. The timing of this suit is unique. Sometime in 1980, the NASD filed two complaints against plaintiffs for their alleged failure to comply with certain rules of that association. On November 24, 1980 the District 8 Business Conduct Committee issued its findings of violations of those rules. As a result, plaintiff WACO was censured and expelled from its membership with the NASD. Plaintiff Prevatte was also censured and barred from association, as a financial principal, with any NASD member. In accordance with the applicable procedure, plaintiffs appealed those decisions to the NASD's Board of Governors. The penalties were stayed pending the outcome of that appeal. On March 19, 1981 the Board issued its opinion affirming the findings and penalties imposed by the District Committee.

From this point forward, the proceedings against plaintiffs are governed by the provisions of the Securities Exchange Act of 1934, 15 U.S.C. §§ 78a-78kk. Specifically, § 78s(d)(1) and § 78s(e)(1) provide the mechanics for appeal of a final decision of the self-regulating NASD to the appropriate regulatory agency (in this case, the Securities and Exchange Commission — hereinafter `SEC').

The SEC is required to give the disciplined member a hearing on appeal but, according to the 1975 amendments to the Act, that hearing may consist only of a review of the NASD's record along with an opportunity for interested parties to present reasons for the affirmance, modification or setting aside of the NASD's action. 15 U.S.C. § 78s(e)(1). Thereafter, review of the SEC's action may be had in the United States Court of Appeals. 15 U.S.C. § 78y. The 1975 amendments also changed the prior provisions of the Act with respect to the status of any NASD-imposed penalties pending review by the SEC. The statute now provides that the application for SEC review shall not operate as a stay unless the Commission decides to the contrary. 15 U.S.C. § 78s(d)(2).

On March 23, 1981, plaintiffs applied for review of the NASD's decision to the SEC. At the same time, plaintiffs requested a stay of the penalties imposed. Prior to any decision by the SEC on the request for a stay, plaintiffs brought suit in this Court for a temporary restraining order and preliminary injunction. They contend that the Act and the NASD rules constitute unconstitutional deprivations of due process of law in several respects.

The attack against the NASD rules centers around the absence of a statute of limitations, the lack of mechanisms for discovery prior to the NASD hearings, the composition of the NASD panels, and prosecutorial involvement in selection of the panel and rendering of the Committee's decision. Plaintiffs further contend that their treatment at the hands of the NASD was arbitrary and capricious. The two aforementioned 1975 amendments to the Securities Exchange Act of 1934 are the focus of the balance of the plaintiffs' constitutional attack. They contend that the combined effect of 15 U.S.C. § 78s(e)(1) and § 78s(d)(2) subjecting them to NASD penalties prior to adjudication of their constitutional claims in the Court of Appeals is a fifth amendment violation of due process of law.

The threshold issue is whether this Court has subject matter jurisdiction to entertain plaintiffs' claims. They assert jurisdiction under 28 U.S.C. § 1331 and § 1337 (federal question); 28 U.S.C. § 2201 and § 2202 (The Declaratory Judgment Act); 5 U.S.C. §§ 702, 705 and 706 (The Administrative Procedures Act) and 15 U.S.C. § 78a et seq. (The Securities Exchange Act of 1934). Assuming that this Court does have jurisdiction, it must decide whether to exercise it prior to any action by the SEC with respect to plaintiffs' appeal.

At the outset this Court notes a well established principle that the Declaratory Judgment Act, 28 U.S.C. §§ 2201, 2202, is not a grant of jurisdiction. The purpose of the Act was to enlarge the scope of remedies available in cases where the federal court has an independent substantive basis for jurisdiction. King v. Sloane, 545 F.2d 7 (6th Cir. 1976); American Airlines, Inc. v. Louisville & Jefferson Co. Air Bd., 269 F.2d 811 (6th Cir. 1959); Muskegon Piston Ring Co. v. Olsen, 307 F.2d 85 (6th Cir. 1962), cert. den. 371 U.S. 952, 83 S.Ct. 508, 9 L.Ed.2d 500; Stanley v. Avery, 387 F.2d 637 (6th Cir. 1968), cert. den. 390 U.S. 1044, 88 S.Ct. 1641, 20 L.Ed.2d 304. Additionally, the Administrative Procedures Act is not an independent grant of jurisdiction. Califano v. Sanders, 430 U.S. 99, 97 S.Ct. 980, 51 L.Ed.2d 192 (1977); Allan v. Securities & Exchange Comm., 577 F.2d 388 (7th Cir. 1978).

Jurisdiction must then lie either under 28 U.S.C. §§ 1331, 1337 or the Securities Exchange Act of 1934. In light of the provisions of 28 U.S.C. § 78y for review in the Court of Appeals after final action by the SEC, the role of the district courts, if any, is not well defined. The indications are, however, that this Court may have subject matter jurisdiction under § 1331 or § 1337 of plaintiffs' constitutional claims unless Congress' intent to foreclose such an avenue of review is manifested by clear and convincing evidence within the Securities Exchange Act. Califano v. Sanders, 430 U.S. 99, 97 S.Ct. 980, 51 L.Ed.2d 192 (1977). The Act has been found not to exhibit such a clear Congressional intent. Wolf Corp. v. Securities & Exchange Comm., 317 F.2d 139 (D.C.Cir.1963); First Jersey Securities, Inc. v. Bergen, 605 F.2d 690 (3rd Cir. 1979). The question of whether to exercise such jurisdiction prior to review of the NASD's action by the SEC must yet be answered.

The First Jersey Securities Court held that the comprehensiveness of the scheme of the Act suggested that the district courts should apply the concept of exhaustion of administrative remedies prior to exercising any jurisdiction they may have. Accordingly, this Court must determine whether the situation presented by this case is sufficient to invoke an exception to the exhaustion requirement.

Two exceptions to that requirement have been recognized in cases involving the Securities Exchange Act — where the administrative process is clearly shown to be inadequate in preventing irreparable injury or where there has been or will be a clear and unambiguous statutory or constitutional violation. First Jersey Securities, Inc. v. Bergen, 605 F.2d 690 (3rd Cir. 1979); Wolf Corp. v. Securities & Exchange Comm., 317 F.2d 139 (D.C.Cir.1963); OKC Corp. v. Williams, 461 F.Supp. 540 (D.C.Tex.1978). See also School District of City of Saginaw, Mich. v. United States, Dept. of HEW, 431 F.Supp. 147 (D.C.Mich.1977) (Title VI); Boise Cascade Corp. v. Federal Trade Comm., 498 F.Supp. 772 (D.C.Del.1980) (antitrust). This Court does not find that, under the present posture of this action, plaintiffs are able to hurdle either of those exceptions.

The mere allegation of a constitutional violation is insufficient to constitute irreparable harm. Boise Cascade Corp. v. Federal Trade Comm., 498 F.Supp. 772 (D.C.Del. 1980). Those claims can be reviewed in the Court of Appeals after exhaustion of the administrative process. Cost incurred by plaintiffs due to any delay in review has been held not to constitute irreparable injury. First Jersey Securities, Inc. v. Bergen, 605 F.2d 690 (3rd Cir. 1979). See also Sampson v. Murray, 415 U.S. 61, 94 S.Ct. 937, 39 L.Ed.2d 166 (1974). Expulsion from the NASD pending review of those claims has been held not to constitute irreparable injury in light of the broad discretion given to the SEC to protect the interests of the investing public. Associated Securities Corp. v. Securities & Exchange Comm., 283 F.2d 773 (10th Cir. 1960).

The ultimate question is whether plaintiffs' claims rise to the level of being clear and unambiguous constitutional violations. This Court cannot say that they do. In general, the Securities Exchange Act and the NASD system of self-regulation have repeatedly withstood constitutional attack. R. H. Johnson & Co. v. Securities & Exchange Comm., 198 F.2d 690 (2nd Cir. 1952), cert. den. 344 U.S. 855, 73 S.Ct. 94, 97 L.Ed. 664; Todd & Co. v. Securities & Exchange Comm., 557 F.2d 1008 (3rd Cir. 1977); First Jersey Securities, Inc. v. Bergen, 605 F.2d 690 (3rd...